RBI’s MPC will complete 5 years: Here are 5 issues that need attention beyond inflation

Finance Minister Nirmala Sitharaman has said the Consumer Price Index (CPI) or retail inflation target of 4% with a range of 2% to 6% needs to be reviewed as the mandate of the first five years of the MPC ends in March. This year. Likely options before the government are maintaining the current 4% target, changing the target upwards, or changing the benchmark itself from CPI to core inflation. or the Wholesale Price Index (WPI). But there are aspects other than the inflation band or the benchmark that require the attention of policymakers.

RBI Inflation Forecast Model

RBI has been behind on inflation projection and needs a better inflation forecasting model. An accurate forecast of inflation is very important for the formulation of monetary policy, as interest rates are set according to the inflationary scenario. Over the past year, the RBI has underestimated retail price inflation. The Covid outbreak and the lockdown have contributed to supply-side shocks, but the record of the pre-covid period is also not very encouraging. RBI’s projected inflation for 2018 and 2019 shows that the Central Bank had overestimated inflation for two years.

RBI liquidity metrics outside of MPC

The central bank has taken a number of liquidity measures outside of the MPC, which means a dilution of the role of the MPC. The new arrangement agreed between the government and the RBI signifies a revision of the inflation target and not the whole framework. But the review should include RBI’s liquidity management and the use of various monetary tools such as reverse repo, bank rate, CRR or exchange rate policy which influence the liquidity in the system thereby diluting the role of the six-member MPC. The recent post-Covid liquidity measures taken by the RBI have seen the dilution of the MPC framework.

Fiscal policy support

The MPC also needs fiscal policy support. The fiscal consolidation path is far from exact. The record of fiscal consolidation over the past 10 years is not encouraging. Remember that the government had to provide fiscal stimulus after the global financial crisis of 2008, which pushed the budget deficit to 6.2% in 2008-09 and 6.6% in 2009-10. Over the past decade, budget deficit figures have fallen to a low of 3.4% in 2018-2019, but have failed to come down to an acceptable level of 3%. And this despite the economic advantage of oil (lower oil prices). After the pandemic, there is yet another excuse for not achieving the goal. The new fiscal consolidation path from 9.5% of GDP in the pandemic year 2020-21 to 4.5% by the end of the fifth year clearly defines a five-year fiscal consolidation path. Should the RBI trust the government’s promise to return to a 4.5% fiscal consolidation path by 2025-26?

RBI’s dual role as debt manager

A new institutional framework for public debt management is needed, just as the MPC was set up for better decision-making. Currently, the RBI’s role as the government’s debt manager conflicts with monetary policy. As the debt manager, the RBI is doing its best to increase public debt at the lowest possible rates while for monetary policy, it should be even-handed and vote for an interest rate hike if it there are good reasons. After the pandemic, the RBI is vocal and open enough to keep and reduce bond yields below 6% and help the government borrow from the market. Now is the time to create a separate debt management department outside the RBI.

Transmission of interest rate

Despite a reduction in key rates of more than 250 basis points over the past two years, lending rates have fallen by just over 100 basis points. Most bank deposits are fixed in nature which lowers the lending rate as the cost of funding is higher. In addition, the bank also competes with postal savings rates where interest rates are higher. It is notorious that the banks do not transfer the benefit to the borrowers, which leads to such a mismatch. Much remains to be done in the area of ​​interest rate transmission.

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